Updates on US Corporate Earnings, Fed Funds Odds

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Updates on US Corporate Earnings, Fed Funds Odds

Two “Data” topics today:

Issue #1: An update on S&P 500 corporate earnings reports and expectations. (Data courtesy of FactSet, link to full report below.)

First, here is an update on how Q4 earnings season is progressing, with 72 percent of S&P companies having reported as of Friday:

  • 77 percent of companies have beaten Wall Street estimates. That is in line with the 5-year average of 76 percent but below the 1-year average of 83 percent.
  • The average earnings beat amount is 8.6 percentage points, the same as the 5-year average but well below the 1-year average of 15.7 pct.
  • 77 percent of reporting companies beat revenue expectations, essentially the same as the last year (78 pct) but well above the 5-year average (68 pct).
  • Revenue beats this quarter have averaged 2.7 percentage points, which is below the 1-year average (3.5 points) but well above the 5-year average (1.5 points).

Comment: Q4 earnings season has come in for criticism because beat rates are not what they’ve been the last 4 quarters, but that misses two broader points. First, S&P 500 profit margins remain very strong at 12.4 percent even with higher cost inflation and both Wall Street analysts and we expect those to hold in 2022. Second, Q4’s absolute earnings power is impressive ($55/share), so let’s expand on that.

Second, as we have been discussing for several months, Q4 2021 earnings expectations were way too low and S&P 500 earnings power continues to improve. At the end of last year Wall Street analysts’ Q4 2021 estimates bubbled up to a $51.25/share estimate for the index, which was below Q3’s $53.83/share actual result. The chart below reflects per-share earnings data and shows the S&P 500 should earn at least $54.90/share in Q4. Not only is that well above estimates, it is a new record.

This chart also shows that Wall Street is just as conservative on its Q1 and Q2 2022 numbers as it was going into Q4 earnings reports. Even though the S&P 500 was running $55/share in earnings power as it started 2022, the Street still thinks the next 2 quarters will show similar or lower bottom line results ($51.90/share and $55.43/share). It is only in the back half of 2022 that analysts expect further earnings improvements.

Comment/Takeaway: the market narrative around S&P 500 earnings right now is clearly that they’ve peaked, so multiples must contract given the “known unknown” of where they may go next. Fair enough – that fits with the uncertainties around Fed policy (more on that in a minute). It does, however, require betting against America’s largest and best-known businesses and believing that macro forces will swamp their now-proven ability to generate earnings growth.

Issue #2: An update on what Fed Funds Futures are predicting for rate policy this year.

March 16th meeting:

  • Futures are now giving coin-flip odds for the question “25 or 50 basis points in March?”
  • The probability of 25 bps stands at 51 percent as of Friday’s close, with the odds of 50 basis points at 49 percent. At least the odds of 75 basis points are back to zero.

June 15th meeting:

  • The highest probability goes to Fed Funds at 100 – 125 basis points, at 46 percent. Since this is the third meeting from now, that implies there will be at least 1 hike of 50 basis points between now and then (3 bumps of 25 bps only gets us to 75 – 100 bps).
  • The odds of the Fed doing more or less between now and then is split very evenly. The probability of Fed Funds at 75 – 100 bps is 25 percent, the same odds as rates being 125 – 150 basis points.

December 14th meeting:

  • The probabilities are all over the board in terms of where Fed Funds will end the year.
  • The modal estimates, each with 29 percent odds, are for rates to be either 150 – 175 basis points (6 hikes of 25 bps, for example) or 175 – 200 bps (7 hikes of 25 bps).
  • But … the odds of Fed Funds being either lower than that range (125 – 150 bps) or higher still (200 – 225 bps) are also the same at 16 percent.

Takeaway: it is hard to imagine capital markets volatility declining until Fed Funds Futures reflect incremental clarity on the path of monetary policy. Even the simplest question – 25 or 50 basis points in March? – is a coin flip just now. As for policy over the remainder of 2022, all the Futures market knows for sure (to 90 percent certainty, anyway) is that Fed Funds will be somewhere between 125 – 150 basis points (5 hikes of 25 bp, for example) and 200 – 225 bps (at least 1 50 bp increase, plus 25s at every other meeting). Fed Funds have been remarkably prescient at calling the direction of rates over the last year, so when this market throws up its hands in confusion you know that no one has an edge on calling what the Fed will do next.

Sources:

FactSet Earnings Insight report: https://www.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_021122.pdf

CME FedWatch: https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html